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CoCos market set to grow ten-fold by 2020, says bond manager

CoCos market set to grow ten-fold by 2020, says bond manager

The contingent convertible bonds universe is set to become increasingly more competitive as more investors switch out of high yield but not everyone knows where to look.

That is the view of Swisscanto’s Daniel Björk, who runs the Swisscanto (LU) Bond Invest COCO fund.

Speaking to Citywire Global, Björk said institutional investors have become more open to the use of these bonds, known as CoCos, but should be focusing on large retail banks for the best bets.

‘We favour strong national championship banks with stable business models. At the moment we find most attractive the Additional Tier 1 (AT1) CoCos from more retail focused banks like BBVA, Santander and KBC’.

‘This is as well as the more defensive Tier 2 CoCos from Credit Suisse and UBS due to its significant capital buffers above the trigger level in their CoCos.’

The appetite for CoCos has become much more prevalent, Björk said, with many fund houses either launching or planning to launch funds to capture this theme.

‘CoCo's are becoming more broadly accepted among institutional investors this year. We hear many investors are switching from high yield, where yields are too low and default risk is too high, and switch into CoCos,’ he said.

While this creates opportunities, Björk said, it does not mean all parts of the market are attractive.

‘For example, we are avoiding smaller Spanish and Italian banks, as well as banks with unsustainable business models. Diversification is also very important, we typically don't have much more than 3% in one name,’ he said.

Björk also pointed to future opportunities, such as the first German CoCo, which is expected to be issued by Deutsche Bank. However, Björk said, at this stage, the Deutsche issue did not expect to invest in at present.

Size shift

The European Central Bank is currently assessing higher trigger levels for CoCo bonds, which would rise from 5.5% to 7% under its forthcoming banking stress tests, Björk said.

He said this trigger level – which represents the point at which capital levels would require a contingent bond would be converted – compares to a 5.125% level under the Basel III/CRD IV regulations.

With the trigger level being raised, Björk said there is potential for increased issuance from banks, which are using the instruments to help raise capital to meet regulatory requirements.

‘Where else in fixed income do you get attractive credit spreads of 400-600bps and yields between 5-8% by investing in bonds from solid investment grade rated issuers? As well as in a sector with a positive fundamental trend with improving solvency and funding profiles,’ he added.

Björk said the market as a whole somewhat resembles the early days of where the old Tier 1 market was at the end of the 1990s and the beginning of 2000s. This, he said, meant there was a huge amount of growth potential.

Looking at the growth of the market, Björk said his team are anticipating the market, which currently stands at €45 billion, to double in size over the next one to two years. This is before reaching a size of around €300-400 billion by 2020, he said.

Over the last 12 months to end of March 2014, the Swisscanto Bond Invest COCO fund has returned 10.8%.

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